The ECJ found that the taxpayer group’s cost savings were marginal when compared to the level of tax benefits, and therefore, that the cost savings did not constitute a valid commercial reason
The case concerns the concept of “valid commercial reasons” and the interpretation of “restructuring or rationalization” operations within the meaning of the EU Merger Directive.
Background
Portuguese tax law allows for tax losses of acquired companies to be offset against the taxable profits of the acquiring company under a merger. However, this benefit is not available if the tax authorities conclude that the transaction was not entered into for valid commercial reasons, such as restructuring or rationalization of the group’s activities. Such restrictions are compatible with the EU Merger Directive (Directive 90/434/EEC) to the extent they impose similar restrictions on the transfer of tax losses to both internal and cross-border operations.
In this case, a Portuguese holding company acquired three other Portuguese holding companies within the same group, through a merger in 2003. The taxpayer requested that the Portuguese tax authorities allow the unused losses incurred by the three acquired companies during the period 1997 to 2002 to be set off against its own taxable profits.
The tax authorities approved the taxpayer’s request in respect of two of the acquired companies, but denied the set off of tax losses incurred by the third company, arguing that there was no valid commercial interest for the taxpayer to have acquired that company. The tax authorities asserted that the third company (1) effectively conducted no activities, (2) did not generate related revenue, (3) had invested only in securities, and (4) was unclear in the origin of its tax losses of €2 million.
The taxpayer countered that the merger and resulting restructuring generated benefits to the group in the form of administrative and management costs savings.
ECJ’s judgment
The ECJ concluded that the group’s cost savings were marginal when compared to the level of tax benefits, and therefore, that the cost savings did not constitute a valid commercial reason.
The ECJ found that for there to be valid commercial reasons, a merger must be motivated by more than purely tax advantages. If several objectives are involved, tax considerations are not to predominate, the ECJ observed.
The ECJ noted that while the third, acquired company did not carry out activities, did not have any holdings, and while the taxpayer’s intention was to take over the losses, this did not rule out the possibility that the merger was conducted for valid commercial reasons. According to the ECJ, although restructurings and rationalizations undertaken for cost saving purposes can involve valid commercial reasons under the Merger Directive, when deciding whether an operation falls under this category, the level of the resulting tax advantages must be taken into account.
The ECJ concluded that it was up to the national court to decide whether the transfer of tax losses as a result of the merger had valid underlying commercial reasons in light of these findings.
To read a November 2011 report about the ECJ judgment in this case, prepared by KPMG’s EU Tax Centre: Foggia – SGPS case (58 KB)